- Email: [email protected]
Banking Union- an European Project with Certain Success Prospects
Available online at www.sciencedirect.com
ScienceDirect Procedia Economics and Finance 8 (2014) 582 – 589
1st International Conference 'Economic Scientific Research - Theoretical, Empirical and Practical Approaches', ESPERA 2013
Banking union- an European project with certain success prospects Petre Prisecarua* a
Institute for World Economy, Bucharest, Romania, Calea 13 Septembrie, no. 13, district 5, Bucharest, 05071, Romania
Abstract Banking union project rising from the sovereign debt crisis of the Eurozone is meant to achieve two goals simultaneously: completion of the single market in financial services, namely the free movement of capital and strengthening of economic and monetary union, especially of the single currency role, aiming at further economic integration and for paving the way to its last stage: full economic union and federal political union. This project that has to be doubled by the fiscal union is more advanced on banking supervision component, where the European Central Bank (ECB) and the European Banking Authority (EBA), involved also in bank assessments and stress tests, play a key role and less advanced on components of bank resolution and common deposit guarantee, the last two involving the creation of common European funds and institutional structures for their proper management. The project will likely to be completed in few years and represents a significant contribution to the reform of EU economic governance which started in 2010, and it was initiated by the European Commission experts together with other experts (see Larosière and Liikanen reports), and it has already resulted in the coordination and the political will displayed by the European Council to carry out the objectives, in the actions undertaken by the legislators (ECOFIN and European Parliament) by adopting regulations and analyzing the proposed directives and in the intense activity carried out by the European Commission, ECB and EBA. The urgency of completing banking union established by the European Council and the commitments made by other European institutions can contribute to a substantial progress until the new European elections (May 2014). Later on it may be taken into account a treaty change, specifically requested by United Kindgom, to clarify certain political and organizational aspects, including also those of fiscal union and political union. © Published by by Elsevier Elsevier B.V. B.V. © 2014 2014 The The Authors. Authors. Published CommitteeofofESPERA ESPERA2013 2013. Selection under responsibility responsibility of of the theOrganizing OrganizingCommittee Selection and and peer-review peer-review under
* Corresponding author. Tel.: 400723.181.072. E-mail address:[email protected]
2212-5671 © 2014 The Authors. Published by Elsevier B.V. Selection and peer-review under responsibility of the Organizing Committee of ESPERA 2013 doi:10.1016/S2212-5671(14)00132-4
Petre Prisecaru / Procedia Economics and Finance 8 (2014) 582 – 589 Keywords:banking union; mechanis; supervision; resolution; deposit guarantee; fund; financial stability
1. Introduction Article aims to highlight the causes, objectives, components and tools for achieving banking union, a complex and difficult process, but imperative in the light of requirements for further financial integration of the EU and related to the elimination or mitigation of vicious circles and systemic risks, to the improvement of Community, national and corporate governance. The correlated approach of the three basic components of banking union and using some legal, institutional, financial and political instruments may provide the success of this project in relatively short while, since the requirements of economic recovery and reducing of public deficits and debts require a new strategic vision of regulatory policies and of European and national decision makers in Europe.
1. Defining European banking union Banking Union is a process of deepening financial integration in the EU, perfect connected to the completing of economic and monetary union (EMU), a process urged by financial crisis effects, which were turned into a massive bail-out of commercial banks from EU with public money, that led to an explosion of public debts in the Euro Area and created serious financial difficulties for many Member States, producing the so-called sovereign debt crisis in the Eurozone. Difficulties experienced by banks during the crisis and then have revealed the requirement of financial stability and improving European economic governance, including by way of creating a banking union and then a fiscal union (see figure no.1). The sovereign debt crisis in the Eurozone and the great difficulties faced by the banks in Ireland, Spain, Greece, Cyprus mainly caused by financing the real estate sector and secondary by risky derivative operations and the purchase of government securities not only revealed major shortcomings of corporative governance in the banking sector but showed that financial stability can not be achieved at national level because of the vicious circle created between banks and governments (shocks transmitted from the government to the banking sector and from banks to the governments) and hence its need to break it through creating banking union. However as the first tool to enhance financial balance of banks and eliminate the financial burden for governments was thought European Stability Mechanism, which was going to ensure direct capitalization of banks in trouble. Should not forget that banks have a major role in the European financial system providing about ¾ of all credit used in the EU (their assets being about 3 times higher than the GDP of EU) and thus having a critical/decisive role in the proper functioning of EU economies.Therefore almost € 4,500 billion of European taxpayers money were used to bail out EU banks from a potential bankruptcy caused by financial crisis. In the graphic no.1 it is presented the situation of the banking sector in EU Member States in the light of liabilities structure at the level of 2013 (second quarter). Similar to the monetary union setting up, Germany was the promoter of banking union as a preliminary condition for the possibility of the European Stability Mechanism to directly capitalize the distressed banks, as in the event that a large bank may collapse the systemic risk would be high and could lead to a new financial crash, public finances being unable to save or bail out banking sector again, with instant and severe effects on the economic and financial situation of the countries involved. Indeed national surveillance authorities could ignore the fact that banks adjust balance sheets, especially the dubious claims, and this due to the fear of the generalized insolvency. There are the negative examples of the U.S. and Japan, in the first case the lax supervision and the deregulation led to the explosion of mortgage loans and related derivatives, with the inherent consequence of financial crisis, in the second case banks overburdened by bad mortgages could no longer finance productive sector and country crossed through two decades of economic deadness. Banking Union was defined as based on four pillars: a single regulatory framework for financial institutions, a Single Surveillance Mechanism (SSM), a harmonized system of deposit guarantee schemes, a Single Resolution Mechanism, the last three being essential components of the union. Establishing banking union involved an intense activity of consultation and debates, after the decision of the European Council in June
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Fiscal Union -Limited structural deficits (0,5%) and budget (3%) -Centralized Budget? -Eurotaxesşieurobonds? -EU Treasury? Banking Union - Single Supervision Mechanism(CRD IV-Basel 2, common prudential rules) -Single Resolution Mechanism (Directive BRR) - European Deposit Guarantee Scheme
EU ECONOMIC GOVERNANCE European Semester 6 Package, 2 Package Fiscal Stability Treaty Growth and Employment Pact Banking Union Fiscal Union?? Instrument : ESM
Fiscal Compact -Structural deficit 0,5% of GDP -Budget deficit 3% of GDP -Public debt 60% of GDP
Macroeconomic Imbalance Procedure - 11 Risk Indicators
Source: Made by the author after some sources Fig.1. Reformed framework of economic governance in EU
Source: European Central Bank, 2013 Graph.1- Liabilities structure of banking sector in 2013 (second quarter)
2012 to assign the supervision of European banking system to European Central Bank under the provisions of Article 127 (6) of the Treaty on the Functioning of the EU (TFEU), followed by European
Petre Prisecaru / Procedia Economics and Finance 8 (2014) 582 – 589
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Commission Communication”A Roadmap towards a Banking Union” of 12 September 2012, showing that single market and banking union reinforce each other and there are three major areas of interest: a) stronger prudential requirements suggested for the banks, regarding capital requirements (CRD4) by the new global standards on bank capital and liquidity; b) coverage degree of national schemes for deposit guarantee (ceiling €100,000); c) recovery and resolution tools for banks in crisis, meant to strengthen the European banking sector and avoid spillover effects. On 2 October 2012 it was published Liikanen Report, worked out by high-level experts, at the request and under the auspices of the European Commission, which recommended actions in five areas: i) mandatory separation of high risk financial activities to those consisting of deposit filing and preserving; ii) additional separation of activities, conditional on a recovery and resolution plan; iii) amendments to use bail out instruments as a resolution manner; iv) tightening of capital requirements on traded assets and mortgage loans; v) strengthening of banks governance and control, including measures restricting or conditioning the managers bonuses. Liikanen Report reviewed the structure and evolution of the banking sector, it has proposed the improvement of regulations on risk management under Basel III rules, on corporative governance, on banking resolution mechanisms, on management and supervision strengthening, on compensation rules for banking staff. The building of institutional framework for banking supervision began in January 2011 when there were created European Banking Authority (EBA), the first one based on Regulation no.1093/2010 and the European Systemic Risk Board (ESRB), the last one in charge with macroprudential surveillance under Regulation no. 1092/2010 and with the involvement of European Central Bank. European Banking Authority (EBA) has only some limited powers to issue standards and recommendations, based on European regulations and directives and banking supervision has remained more the responsibility of national authorities, with or without the involvement of national central banks. European System of Financial Supervision consists of the European Systemic Risk Board in charge with macroprudential supervision and dealing in particular with monitoring and preventing the systemic risk at Union level and issuing of warnings and recommendations, as well as 3 European authorities (banking, insurance and pensions, capital markets), the European Central Bank, national supervisory authorities (banking, insurance, capital markets) in charge mainly with microprudential supervision, but also with some macroprudential functions. Besides creating the framework for macroprudential and microprudential supervision, the achievement of banking union was preceded by some measures and analysis or assessment phases of the European banking sector, undertaken by the European Commission, such as stress tests performed by the Committee of European Banking Supervisors (CEBS) from 2009, when the first test was done, followed by the second in July 2010 and the third in July 2011, here acting together with the European Banking Authority. The tests are intended to assess the resilience of financial institutions to adverse market developments, as well as an overall assessment of systemic risk in the banking system of the EU. Tests are performed based on methodologies, scenarios and key assumptions developed by EBA, the ESRB, the ECB and the European Commission. The results of the third test were published on 15 July 2011 and they showed that a number of eight banks out of a total of 90 failed the stress test, of which five in Spain, two in Greece and one in Austria. Subsequently EBA has postponed the stress tests until 2014 to allow the ECB to control the situation and the quality of bank assets and to dispel the fears related to the deterioration of macroeconomic conditions after the financial crisis. 2. Concrete achievements of the European institutions towards banking union formation The European Council has exercised a coordination, guidance and control activity of the process establishing the banking union, which has been debated over the past five quarterly summits on the section devoted to Economic and Monetary Union. The President of European Council has discussed together with the presidents of other institutions involved in the project, especially the President of European Commission, the President of the Eurogroup and the President of the ECB, the main aspects of setting up the banking union. At the beginning the debates focused on the Single Supervision Mechanism, and the powers of the ECB (Council placing supervision activity in ECB’s mission) and the powers of EBA, then on the single banking resolution mechanism and the deposit guarantee schemes. European Council set the timetable for measures to accomplish the banking union, including a final term to realize it.
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The main EU legislative bodies - EU Council (ECOFIN) and the European Parliament (EP)- had a fruitful activity: the first one has adopted a Regulation for the Single Supervision Mechanism and a new Regulation amending the old Regulation establishing European Banking Authority (EBA) and in June 2013 communicated its position on the draft directive establishing a framework for the recovery and resolution of credit institutions and investment firms, European resolution and deposit guarantee funds are going to be covered with the contributions made by credit institutions, while the second one has voted in September 2013 the establisment of a supervisory banking authority of Euro area placed under the auspices of the ECB, whose activities will be periodically examined by EP, and is going to engage in the adoption of directives on bank resolution and deposit guarantee in EU proposed by European Commission and approved by the ECOFIN. The European Commission took the initiative of analyses related to banking union and had the important legislative initiative at all levels of its buiding. European Commission is the connecting link between all EU and national institutions involved in the process, her expertise having a substantial contribution to the European Council decision making and also for supporting the adoption of secondary legislation. The Commission works closely with the ECB and EBA on many technical aspects of achieving banking union. In July 2013 the European Commission proposed the Single Resolution Mechanism (SSM) and state aid rules for the banks in crisis. European Central Bank established within it a Supervision Board, separately from monetary policy tasks, and will be involved in evaluating the participating banks in SSM through audits and stress tests. Supervision Board will have in view around 150 banks in the Eurozone, which (each) have total assets over 30 billion €, have a balance sheet over 20% of a member state’s Gross National Income, are among the three most important credit institutions in that country, receive direct support from European Stability Mechanism (Dorothea Schäfer, 2013). European Banking Authority stands in terms of technical support the ECB activities in line with supervision, testing the resilience, mediation and establishing technical standards. In conclusion it can be said that there have been made rapid progresses towards banking union constitution on behalf of European institutions that have effectively collaborated and almost without any flaws for adopting the secondary legislation required to materialize the three components of the union: surveillance, resolution and deposit guarantee. Establishment of two European funds -resolution and deposit guarantee -will still be difficult because of severe financial constraints and large losses recorded by banks during the financial and economic crisis. It will probably take at least three years to complete the project, but the urgency of completing banking union recently established by the European Council and the commitments of other EU institutions may contribute to a substantial progress until the new European elections (May 2014). Afterwards one may have in view a change of the EU Treaties, expressly requested by United Kindgom, clarifying the political and organizational aspects, including those related to fiscal union and political union. 3. Expert opinions on achieving the financial stability and banking union Mugur Isărescu (2013), The Governor of Romanian Central Bank, has recently appreciated that the lack of banking union and fiscal union somewhat embrittled the monetary union and imposed a high cost of debt financing because of market perception, noting an important paradigm shift on the line to ensure the continuity of critical financial services through a combination of preventive actions with corrective solutions. He believes that banking regulations, although they have a more pronounced macroprudential orientation, are not sufficient to prevent the accumulation of systemic vulnerabilities, other components of the mix of macroeconomic policies should avoid the generation of large variations in the demand for loans, especially by promoting an anti-cyclical revenue policy in order to prevent excessive growth of credit demand over the medium-term repayment capacity of borrowers that may withstand high pressures when the economy adjusts. Since mortgage loans and derivative operations have boosted moral hazard in the banking sector, banks should finance mainly the most dynamic sectors and leading to economic growth, so it would be desirable to review the policies of commercial banks to finance the productive activities, generating not only added value, but also a sustainable income. Daniel Dăianu (2013), First Deputy Chairman of the Financial Supervision Authority, notes the impact of financial integration progress, the complexity and risks of financial operations/innovations, including the failure of
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regulatory and supervisory systems, the shortcomings of corporate governance, the market manipulation and the pursuit of high profits associated with high risks rapidly propagated in the system. Dăianu also combats the great illusion that price stability (low inflation) would ensure financial stability based on the assumption of efficient markets. Clear progress towards the legislative building and especially to institutional one, coupled with macro and microprudential policies, improvement of European and global governance are positive factors, but many other requirements are emerging, such as unsolved structural issues linked to bank size and separation of their activities and the need for a new Basel agreement (IV), adaptation of regulation and supervision to the specificity of electronic transactions, to the complexity and the strong integration of markets, to the proliferation and dissemination of risks. Dăianu remarked that the transformation of depositors into investors through restructuring/resolution changes the game rules affecting bank liquidity situation at a time when liquidity trap occurs and may lead to large capital migrations outside banking sector or outside the EU. Florin Georgescu (2013), First Deputy Governor of Romanian Central Bank, focuses on macroprudential regulation to prevent systemic vulnerabilities including actions targeting to cycle amplitude of financial risk which means a counter-cyclical role of this policy. Macroeconomic policy mix must avoid the excessive growth of credit demand over the flow of domestic savings and hence fiscal policy and income policy in a country should play an active role in limiting the growth of credit demand and also in preventing assets price overvaluation. The issue of banking union enrolls in the new framework of EU economic governance together with fiscal disciplinary measures by means of the Fiscal Compact and Scoreboard Indicators (with the 11 indicators) and by a possible fiscal union. He highlights the merits of the Basel agreements on strengthening the resilience of the banking system to shocks and believes that it was created to a large extent an appropriate institutional and legislative framework for banking union through the new tasks of the ECB, the existence and activities of the European Banking Authority and the European Commission's recent proposals on the Single Resolution Mechanism and state aid rules for the banks in crisis, as well as the Directives BRR and DGS. Michel Barnier (2012), European Commissioner for Internal Market and Services, regards as necessary the insurance of financial markets stability and efficiency, restoring the people trust on them, strongly supporting the real economy by the financial sector. He emphasizes the important role of the Single Supervision Mechanism which is going to to become fully operational in 12 months after the entry into force of SSM Regulation, probably during the summer of 2014. The new rules on bank own funds and liquidity are essential to prevent banking crises, but it is important the activity of supervision and prevention of a possible crisis. Resolution measures must have a preventive character and internal recapitalization of bank by shareholders and creditors takes the leading role, each state will have a national fund that complements the European funds. Ultimate responsibility of bank resolution and funding it is still a subject of dispute between the European and national decision makers. For Daniel Gros (2013), Director of CEPS, the achievement of banking union is the means to break the vicious link between banks and sovereign states, the Single Supervision Mechanism (SSM), designed to prevent the systemic risks, must be accompanied by a Single Resolution Mechanism(SRM). Banks should be weaned from investing in government bonds because sovereign debts can no longer be considered risk free. Risk of sovereign debt should not be set according to the ratings but it should be connected to fiscal/budget deficit and public debt level, and to the Macroeconomic Imbalance Procedure, administered by the European Commission under the European Semester. In 2012, in the major EU countries, banks had a huge debt exposure on sovereign debt (over 100%) and it would be desirable that under the provisions of Large Exposure Directive banks should not hold government bonds over 25% of their own capital and much of the sovereign debt to be held by individuals (households) and/or investment funds. In Cyprus case Daniel Gros considered that foreign depositors, much of them being Russian oligarchs, were in search of high yields and they should bear a large part of the losses. Douglas J. Elliott (2012), from the Brookings Institution, believes that the best solution would be to strengthen the role of the European Banking Authority (EBA), setting up of a new bank resolution authority, proposed by the European Commission, the establishment of risk premiums to cover bank losses, avoiding tensions with Great Britain. The motivations for building banking union are quite consistent: counteracting the weaknesses of banking system and reducing systemic risk for banks that may potentiate the euro crisis, restoration of the ECB's monetary policy effectiveness, further integration of the European banking system and completion of the single banking market. Banking union must be accompanied by a fiscal union to prevent moral hazard and to break the vicious circle created between banks and governments by public debt. Elliot raises the question of macroprudential policies
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distinct of microprudential policies, the first are operating in the entire financial system, the latest at the level of banking actors. The three components of banking union-supervision, resolution and deposit guarantee-are closely related and therefore the process should not take too long time. Bernhard Speyer (2013) of the research department of Deutsche Bank believes that there is an obvious progress towards banking union but challenges remain on line to building the institutional framework. Before starting the Single Supervision Mechanism it is expected to perform stress tests by EBA but it would be more needed the implementation of Balance Sheet Assesment (BSA) than the stress tests. Speyer sees the need to change or improve the provisions of the Treaty (TFEU) besides the adoption of the necessary directives. There are overlaps of competences between European level and national level, and some reluctances on cession of sovereignty and on decision centralization at the EU level. There are serious financial constraints on the establishment of joint European resolution and deposit guarantee funds. Conclusions 1) Creating banking union became necessary to break the vicious circle between governments and banks to restrain or eliminate the risks of corporate governance deficiencies and systemic risks, to combine macroprudential policies with microprudential policies, to appreciably diminish the moral hazard and ensure the EU financial stability; 2) The complexity of financial integration, of financial operations and innovation requires not only structural measures in the banking system but also legislative, institutional, policy and governance changes (at all levels). There are opinions that the mix of macroeconomic policies should aim at the cyclic character of loans demand, ensuring its sustainable level, and banks must shift from mortgage and derivative operations towards dynamic economic sectors and effective productive activities; 3) Large exposure of banks to sovereign debt has created evident vulnerabilities, therefore investments in government bonds must be limited to a percentage of up to 25% of their own capital, the main investors will be individuals (households) and/or investment funds, as in the U.S.; 4) Despite the skepticism of economic observers the progress towards banking union building was spectacular and quite fast, European institutions have acted coordinated and effectively, according to the tasks they have. Besides redefining functions/activities of the European Banking Authority, it was established Supervisory Board (CSB) which functions within the ECB, there have recently been made proposals of the European Commission for a Single Resolution Mechanism and state aid rules for eligible banks being in crisis, including directives BRR and DGS; 5) Banking Union with the three components-surveillance, resolution and deposit guarantee- at the European level, did not start from scratch, it was preceded by the creation of a European System of Financial Supervision, consisting of the European Systemic Risk Board and the 3 European authorities (banking, insurance and pensions, capital markets), as well as by transposing of the content of Basel agreements into directives.That is why it was easier to move quickly on banking supervision component, because the other two components require the establishment of common European funds difficult to constitute under the present financial circumstances; 6) Banking Resolution requires not only a pool but instead a fundamental change of actors role towards transforming the depositors/creditors into investors that together with the shareholders will bear the costs of restructuring/resolution, which may seriously affect the banks liquidity situation and lead to high bank capital migrations outside the sector or outside the EU; 7) Strong interdependence of the three components of the banking union requires the urgency of completing the banking union within a reasonable period of time (three years) and probably a change of treaties after Euroelections from 2014, specifically requested by UK, but also embraced by other states, in order to clarify several legal, institutional, organizational, political aspects, including a possible fiscal union and a political union under federal form. 8) There is the opinion of many European officials that the banking union must be complemented quickly by a close fiscal union characterized through the establishment of a European strong budget, launch of Eurobonds,
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creating a consolidated coordination mechanism of national budgets, achieving of remanent and completely independent national budgets, harmonization of direct taxation and approach of indirect taxation levels.
References Barnier, M., 2012. L’union bancaire sera complète en 2013, Liberation, 4 Août, bruxelles.blogs.liberation.fr/; supervision architecture of financial Dăianu, D., 2013. Content of Regulation and Supervision is the Problem, Colloquy "Towards a new markets in European Union", NBR, 18 July; Elliot, J.D., 2012. Key Issues on European Banking Union, Trade-Offs and Some Recommendations, Global Economy&Development, Working Paper 52, Brookings Institution, November; Georgescu F., 2013. Reform of banking supervision to ensure financial stability and sustainable economic growth, Colloquy "Towards a new supervision architecture of financial markets in European Union", NBR,18 July; Gros, D., 2013. Banking Regulation, Banking Union with a Sovereign Virus, Intereconomics, No. 2-March/Aprilie; Isărescu, M., 2013. Introductive word of NBR governor, Colloquy "Towards a new supervision architecture of financial markets in European Union", NBR,18 July; Schäfer D., 2013.Banking Supervision in the Eurozone, Editorial, Intereconomics, January/February; Speyer B., 2013, EU Banking Union, Right idea, poor execution, EU Monitor, European Integration, September, 4.
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ScienceDirect Procedia Economics and Finance 8 (2014) 582 – 589
1st International Conference 'Economic Scientific Research - Theoretical, Empirical and Practical Approaches', ESPERA 2013
Banking union- an European project with certain success prospects Petre Prisecarua* a
Institute for World Economy, Bucharest, Romania, Calea 13 Septembrie, no. 13, district 5, Bucharest, 05071, Romania
Abstract Banking union project rising from the sovereign debt crisis of the Eurozone is meant to achieve two goals simultaneously: completion of the single market in financial services, namely the free movement of capital and strengthening of economic and monetary union, especially of the single currency role, aiming at further economic integration and for paving the way to its last stage: full economic union and federal political union. This project that has to be doubled by the fiscal union is more advanced on banking supervision component, where the European Central Bank (ECB) and the European Banking Authority (EBA), involved also in bank assessments and stress tests, play a key role and less advanced on components of bank resolution and common deposit guarantee, the last two involving the creation of common European funds and institutional structures for their proper management. The project will likely to be completed in few years and represents a significant contribution to the reform of EU economic governance which started in 2010, and it was initiated by the European Commission experts together with other experts (see Larosière and Liikanen reports), and it has already resulted in the coordination and the political will displayed by the European Council to carry out the objectives, in the actions undertaken by the legislators (ECOFIN and European Parliament) by adopting regulations and analyzing the proposed directives and in the intense activity carried out by the European Commission, ECB and EBA. The urgency of completing banking union established by the European Council and the commitments made by other European institutions can contribute to a substantial progress until the new European elections (May 2014). Later on it may be taken into account a treaty change, specifically requested by United Kindgom, to clarify certain political and organizational aspects, including also those of fiscal union and political union. © Published by by Elsevier Elsevier B.V. B.V. © 2014 2014 The The Authors. Authors. Published CommitteeofofESPERA ESPERA2013 2013. Selection under responsibility responsibility of of the theOrganizing OrganizingCommittee Selection and and peer-review peer-review under
* Corresponding author. Tel.: 400723.181.072. E-mail address:[email protected]
2212-5671 © 2014 The Authors. Published by Elsevier B.V. Selection and peer-review under responsibility of the Organizing Committee of ESPERA 2013 doi:10.1016/S2212-5671(14)00132-4
Petre Prisecaru / Procedia Economics and Finance 8 (2014) 582 – 589 Keywords:banking union; mechanis; supervision; resolution; deposit guarantee; fund; financial stability
1. Introduction Article aims to highlight the causes, objectives, components and tools for achieving banking union, a complex and difficult process, but imperative in the light of requirements for further financial integration of the EU and related to the elimination or mitigation of vicious circles and systemic risks, to the improvement of Community, national and corporate governance. The correlated approach of the three basic components of banking union and using some legal, institutional, financial and political instruments may provide the success of this project in relatively short while, since the requirements of economic recovery and reducing of public deficits and debts require a new strategic vision of regulatory policies and of European and national decision makers in Europe.
1. Defining European banking union Banking Union is a process of deepening financial integration in the EU, perfect connected to the completing of economic and monetary union (EMU), a process urged by financial crisis effects, which were turned into a massive bail-out of commercial banks from EU with public money, that led to an explosion of public debts in the Euro Area and created serious financial difficulties for many Member States, producing the so-called sovereign debt crisis in the Eurozone. Difficulties experienced by banks during the crisis and then have revealed the requirement of financial stability and improving European economic governance, including by way of creating a banking union and then a fiscal union (see figure no.1). The sovereign debt crisis in the Eurozone and the great difficulties faced by the banks in Ireland, Spain, Greece, Cyprus mainly caused by financing the real estate sector and secondary by risky derivative operations and the purchase of government securities not only revealed major shortcomings of corporative governance in the banking sector but showed that financial stability can not be achieved at national level because of the vicious circle created between banks and governments (shocks transmitted from the government to the banking sector and from banks to the governments) and hence its need to break it through creating banking union. However as the first tool to enhance financial balance of banks and eliminate the financial burden for governments was thought European Stability Mechanism, which was going to ensure direct capitalization of banks in trouble. Should not forget that banks have a major role in the European financial system providing about ¾ of all credit used in the EU (their assets being about 3 times higher than the GDP of EU) and thus having a critical/decisive role in the proper functioning of EU economies.Therefore almost € 4,500 billion of European taxpayers money were used to bail out EU banks from a potential bankruptcy caused by financial crisis. In the graphic no.1 it is presented the situation of the banking sector in EU Member States in the light of liabilities structure at the level of 2013 (second quarter). Similar to the monetary union setting up, Germany was the promoter of banking union as a preliminary condition for the possibility of the European Stability Mechanism to directly capitalize the distressed banks, as in the event that a large bank may collapse the systemic risk would be high and could lead to a new financial crash, public finances being unable to save or bail out banking sector again, with instant and severe effects on the economic and financial situation of the countries involved. Indeed national surveillance authorities could ignore the fact that banks adjust balance sheets, especially the dubious claims, and this due to the fear of the generalized insolvency. There are the negative examples of the U.S. and Japan, in the first case the lax supervision and the deregulation led to the explosion of mortgage loans and related derivatives, with the inherent consequence of financial crisis, in the second case banks overburdened by bad mortgages could no longer finance productive sector and country crossed through two decades of economic deadness. Banking Union was defined as based on four pillars: a single regulatory framework for financial institutions, a Single Surveillance Mechanism (SSM), a harmonized system of deposit guarantee schemes, a Single Resolution Mechanism, the last three being essential components of the union. Establishing banking union involved an intense activity of consultation and debates, after the decision of the European Council in June
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Petre Prisecaru / Procedia Economics and Finance 8 (2014) 582 – 589
Fiscal Union -Limited structural deficits (0,5%) and budget (3%) -Centralized Budget? -Eurotaxesşieurobonds? -EU Treasury? Banking Union - Single Supervision Mechanism(CRD IV-Basel 2, common prudential rules) -Single Resolution Mechanism (Directive BRR) - European Deposit Guarantee Scheme
EU ECONOMIC GOVERNANCE European Semester 6 Package, 2 Package Fiscal Stability Treaty Growth and Employment Pact Banking Union Fiscal Union?? Instrument : ESM
Fiscal Compact -Structural deficit 0,5% of GDP -Budget deficit 3% of GDP -Public debt 60% of GDP
Macroeconomic Imbalance Procedure - 11 Risk Indicators
Source: Made by the author after some sources Fig.1. Reformed framework of economic governance in EU
Source: European Central Bank, 2013 Graph.1- Liabilities structure of banking sector in 2013 (second quarter)
2012 to assign the supervision of European banking system to European Central Bank under the provisions of Article 127 (6) of the Treaty on the Functioning of the EU (TFEU), followed by European
Petre Prisecaru / Procedia Economics and Finance 8 (2014) 582 – 589
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Commission Communication”A Roadmap towards a Banking Union” of 12 September 2012, showing that single market and banking union reinforce each other and there are three major areas of interest: a) stronger prudential requirements suggested for the banks, regarding capital requirements (CRD4) by the new global standards on bank capital and liquidity; b) coverage degree of national schemes for deposit guarantee (ceiling €100,000); c) recovery and resolution tools for banks in crisis, meant to strengthen the European banking sector and avoid spillover effects. On 2 October 2012 it was published Liikanen Report, worked out by high-level experts, at the request and under the auspices of the European Commission, which recommended actions in five areas: i) mandatory separation of high risk financial activities to those consisting of deposit filing and preserving; ii) additional separation of activities, conditional on a recovery and resolution plan; iii) amendments to use bail out instruments as a resolution manner; iv) tightening of capital requirements on traded assets and mortgage loans; v) strengthening of banks governance and control, including measures restricting or conditioning the managers bonuses. Liikanen Report reviewed the structure and evolution of the banking sector, it has proposed the improvement of regulations on risk management under Basel III rules, on corporative governance, on banking resolution mechanisms, on management and supervision strengthening, on compensation rules for banking staff. The building of institutional framework for banking supervision began in January 2011 when there were created European Banking Authority (EBA), the first one based on Regulation no.1093/2010 and the European Systemic Risk Board (ESRB), the last one in charge with macroprudential surveillance under Regulation no. 1092/2010 and with the involvement of European Central Bank. European Banking Authority (EBA) has only some limited powers to issue standards and recommendations, based on European regulations and directives and banking supervision has remained more the responsibility of national authorities, with or without the involvement of national central banks. European System of Financial Supervision consists of the European Systemic Risk Board in charge with macroprudential supervision and dealing in particular with monitoring and preventing the systemic risk at Union level and issuing of warnings and recommendations, as well as 3 European authorities (banking, insurance and pensions, capital markets), the European Central Bank, national supervisory authorities (banking, insurance, capital markets) in charge mainly with microprudential supervision, but also with some macroprudential functions. Besides creating the framework for macroprudential and microprudential supervision, the achievement of banking union was preceded by some measures and analysis or assessment phases of the European banking sector, undertaken by the European Commission, such as stress tests performed by the Committee of European Banking Supervisors (CEBS) from 2009, when the first test was done, followed by the second in July 2010 and the third in July 2011, here acting together with the European Banking Authority. The tests are intended to assess the resilience of financial institutions to adverse market developments, as well as an overall assessment of systemic risk in the banking system of the EU. Tests are performed based on methodologies, scenarios and key assumptions developed by EBA, the ESRB, the ECB and the European Commission. The results of the third test were published on 15 July 2011 and they showed that a number of eight banks out of a total of 90 failed the stress test, of which five in Spain, two in Greece and one in Austria. Subsequently EBA has postponed the stress tests until 2014 to allow the ECB to control the situation and the quality of bank assets and to dispel the fears related to the deterioration of macroeconomic conditions after the financial crisis. 2. Concrete achievements of the European institutions towards banking union formation The European Council has exercised a coordination, guidance and control activity of the process establishing the banking union, which has been debated over the past five quarterly summits on the section devoted to Economic and Monetary Union. The President of European Council has discussed together with the presidents of other institutions involved in the project, especially the President of European Commission, the President of the Eurogroup and the President of the ECB, the main aspects of setting up the banking union. At the beginning the debates focused on the Single Supervision Mechanism, and the powers of the ECB (Council placing supervision activity in ECB’s mission) and the powers of EBA, then on the single banking resolution mechanism and the deposit guarantee schemes. European Council set the timetable for measures to accomplish the banking union, including a final term to realize it.
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The main EU legislative bodies - EU Council (ECOFIN) and the European Parliament (EP)- had a fruitful activity: the first one has adopted a Regulation for the Single Supervision Mechanism and a new Regulation amending the old Regulation establishing European Banking Authority (EBA) and in June 2013 communicated its position on the draft directive establishing a framework for the recovery and resolution of credit institutions and investment firms, European resolution and deposit guarantee funds are going to be covered with the contributions made by credit institutions, while the second one has voted in September 2013 the establisment of a supervisory banking authority of Euro area placed under the auspices of the ECB, whose activities will be periodically examined by EP, and is going to engage in the adoption of directives on bank resolution and deposit guarantee in EU proposed by European Commission and approved by the ECOFIN. The European Commission took the initiative of analyses related to banking union and had the important legislative initiative at all levels of its buiding. European Commission is the connecting link between all EU and national institutions involved in the process, her expertise having a substantial contribution to the European Council decision making and also for supporting the adoption of secondary legislation. The Commission works closely with the ECB and EBA on many technical aspects of achieving banking union. In July 2013 the European Commission proposed the Single Resolution Mechanism (SSM) and state aid rules for the banks in crisis. European Central Bank established within it a Supervision Board, separately from monetary policy tasks, and will be involved in evaluating the participating banks in SSM through audits and stress tests. Supervision Board will have in view around 150 banks in the Eurozone, which (each) have total assets over 30 billion €, have a balance sheet over 20% of a member state’s Gross National Income, are among the three most important credit institutions in that country, receive direct support from European Stability Mechanism (Dorothea Schäfer, 2013). European Banking Authority stands in terms of technical support the ECB activities in line with supervision, testing the resilience, mediation and establishing technical standards. In conclusion it can be said that there have been made rapid progresses towards banking union constitution on behalf of European institutions that have effectively collaborated and almost without any flaws for adopting the secondary legislation required to materialize the three components of the union: surveillance, resolution and deposit guarantee. Establishment of two European funds -resolution and deposit guarantee -will still be difficult because of severe financial constraints and large losses recorded by banks during the financial and economic crisis. It will probably take at least three years to complete the project, but the urgency of completing banking union recently established by the European Council and the commitments of other EU institutions may contribute to a substantial progress until the new European elections (May 2014). Afterwards one may have in view a change of the EU Treaties, expressly requested by United Kindgom, clarifying the political and organizational aspects, including those related to fiscal union and political union. 3. Expert opinions on achieving the financial stability and banking union Mugur Isărescu (2013), The Governor of Romanian Central Bank, has recently appreciated that the lack of banking union and fiscal union somewhat embrittled the monetary union and imposed a high cost of debt financing because of market perception, noting an important paradigm shift on the line to ensure the continuity of critical financial services through a combination of preventive actions with corrective solutions. He believes that banking regulations, although they have a more pronounced macroprudential orientation, are not sufficient to prevent the accumulation of systemic vulnerabilities, other components of the mix of macroeconomic policies should avoid the generation of large variations in the demand for loans, especially by promoting an anti-cyclical revenue policy in order to prevent excessive growth of credit demand over the medium-term repayment capacity of borrowers that may withstand high pressures when the economy adjusts. Since mortgage loans and derivative operations have boosted moral hazard in the banking sector, banks should finance mainly the most dynamic sectors and leading to economic growth, so it would be desirable to review the policies of commercial banks to finance the productive activities, generating not only added value, but also a sustainable income. Daniel Dăianu (2013), First Deputy Chairman of the Financial Supervision Authority, notes the impact of financial integration progress, the complexity and risks of financial operations/innovations, including the failure of
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regulatory and supervisory systems, the shortcomings of corporate governance, the market manipulation and the pursuit of high profits associated with high risks rapidly propagated in the system. Dăianu also combats the great illusion that price stability (low inflation) would ensure financial stability based on the assumption of efficient markets. Clear progress towards the legislative building and especially to institutional one, coupled with macro and microprudential policies, improvement of European and global governance are positive factors, but many other requirements are emerging, such as unsolved structural issues linked to bank size and separation of their activities and the need for a new Basel agreement (IV), adaptation of regulation and supervision to the specificity of electronic transactions, to the complexity and the strong integration of markets, to the proliferation and dissemination of risks. Dăianu remarked that the transformation of depositors into investors through restructuring/resolution changes the game rules affecting bank liquidity situation at a time when liquidity trap occurs and may lead to large capital migrations outside banking sector or outside the EU. Florin Georgescu (2013), First Deputy Governor of Romanian Central Bank, focuses on macroprudential regulation to prevent systemic vulnerabilities including actions targeting to cycle amplitude of financial risk which means a counter-cyclical role of this policy. Macroeconomic policy mix must avoid the excessive growth of credit demand over the flow of domestic savings and hence fiscal policy and income policy in a country should play an active role in limiting the growth of credit demand and also in preventing assets price overvaluation. The issue of banking union enrolls in the new framework of EU economic governance together with fiscal disciplinary measures by means of the Fiscal Compact and Scoreboard Indicators (with the 11 indicators) and by a possible fiscal union. He highlights the merits of the Basel agreements on strengthening the resilience of the banking system to shocks and believes that it was created to a large extent an appropriate institutional and legislative framework for banking union through the new tasks of the ECB, the existence and activities of the European Banking Authority and the European Commission's recent proposals on the Single Resolution Mechanism and state aid rules for the banks in crisis, as well as the Directives BRR and DGS. Michel Barnier (2012), European Commissioner for Internal Market and Services, regards as necessary the insurance of financial markets stability and efficiency, restoring the people trust on them, strongly supporting the real economy by the financial sector. He emphasizes the important role of the Single Supervision Mechanism which is going to to become fully operational in 12 months after the entry into force of SSM Regulation, probably during the summer of 2014. The new rules on bank own funds and liquidity are essential to prevent banking crises, but it is important the activity of supervision and prevention of a possible crisis. Resolution measures must have a preventive character and internal recapitalization of bank by shareholders and creditors takes the leading role, each state will have a national fund that complements the European funds. Ultimate responsibility of bank resolution and funding it is still a subject of dispute between the European and national decision makers. For Daniel Gros (2013), Director of CEPS, the achievement of banking union is the means to break the vicious link between banks and sovereign states, the Single Supervision Mechanism (SSM), designed to prevent the systemic risks, must be accompanied by a Single Resolution Mechanism(SRM). Banks should be weaned from investing in government bonds because sovereign debts can no longer be considered risk free. Risk of sovereign debt should not be set according to the ratings but it should be connected to fiscal/budget deficit and public debt level, and to the Macroeconomic Imbalance Procedure, administered by the European Commission under the European Semester. In 2012, in the major EU countries, banks had a huge debt exposure on sovereign debt (over 100%) and it would be desirable that under the provisions of Large Exposure Directive banks should not hold government bonds over 25% of their own capital and much of the sovereign debt to be held by individuals (households) and/or investment funds. In Cyprus case Daniel Gros considered that foreign depositors, much of them being Russian oligarchs, were in search of high yields and they should bear a large part of the losses. Douglas J. Elliott (2012), from the Brookings Institution, believes that the best solution would be to strengthen the role of the European Banking Authority (EBA), setting up of a new bank resolution authority, proposed by the European Commission, the establishment of risk premiums to cover bank losses, avoiding tensions with Great Britain. The motivations for building banking union are quite consistent: counteracting the weaknesses of banking system and reducing systemic risk for banks that may potentiate the euro crisis, restoration of the ECB's monetary policy effectiveness, further integration of the European banking system and completion of the single banking market. Banking union must be accompanied by a fiscal union to prevent moral hazard and to break the vicious circle created between banks and governments by public debt. Elliot raises the question of macroprudential policies
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distinct of microprudential policies, the first are operating in the entire financial system, the latest at the level of banking actors. The three components of banking union-supervision, resolution and deposit guarantee-are closely related and therefore the process should not take too long time. Bernhard Speyer (2013) of the research department of Deutsche Bank believes that there is an obvious progress towards banking union but challenges remain on line to building the institutional framework. Before starting the Single Supervision Mechanism it is expected to perform stress tests by EBA but it would be more needed the implementation of Balance Sheet Assesment (BSA) than the stress tests. Speyer sees the need to change or improve the provisions of the Treaty (TFEU) besides the adoption of the necessary directives. There are overlaps of competences between European level and national level, and some reluctances on cession of sovereignty and on decision centralization at the EU level. There are serious financial constraints on the establishment of joint European resolution and deposit guarantee funds. Conclusions 1) Creating banking union became necessary to break the vicious circle between governments and banks to restrain or eliminate the risks of corporate governance deficiencies and systemic risks, to combine macroprudential policies with microprudential policies, to appreciably diminish the moral hazard and ensure the EU financial stability; 2) The complexity of financial integration, of financial operations and innovation requires not only structural measures in the banking system but also legislative, institutional, policy and governance changes (at all levels). There are opinions that the mix of macroeconomic policies should aim at the cyclic character of loans demand, ensuring its sustainable level, and banks must shift from mortgage and derivative operations towards dynamic economic sectors and effective productive activities; 3) Large exposure of banks to sovereign debt has created evident vulnerabilities, therefore investments in government bonds must be limited to a percentage of up to 25% of their own capital, the main investors will be individuals (households) and/or investment funds, as in the U.S.; 4) Despite the skepticism of economic observers the progress towards banking union building was spectacular and quite fast, European institutions have acted coordinated and effectively, according to the tasks they have. Besides redefining functions/activities of the European Banking Authority, it was established Supervisory Board (CSB) which functions within the ECB, there have recently been made proposals of the European Commission for a Single Resolution Mechanism and state aid rules for eligible banks being in crisis, including directives BRR and DGS; 5) Banking Union with the three components-surveillance, resolution and deposit guarantee- at the European level, did not start from scratch, it was preceded by the creation of a European System of Financial Supervision, consisting of the European Systemic Risk Board and the 3 European authorities (banking, insurance and pensions, capital markets), as well as by transposing of the content of Basel agreements into directives.That is why it was easier to move quickly on banking supervision component, because the other two components require the establishment of common European funds difficult to constitute under the present financial circumstances; 6) Banking Resolution requires not only a pool but instead a fundamental change of actors role towards transforming the depositors/creditors into investors that together with the shareholders will bear the costs of restructuring/resolution, which may seriously affect the banks liquidity situation and lead to high bank capital migrations outside the sector or outside the EU; 7) Strong interdependence of the three components of the banking union requires the urgency of completing the banking union within a reasonable period of time (three years) and probably a change of treaties after Euroelections from 2014, specifically requested by UK, but also embraced by other states, in order to clarify several legal, institutional, organizational, political aspects, including a possible fiscal union and a political union under federal form. 8) There is the opinion of many European officials that the banking union must be complemented quickly by a close fiscal union characterized through the establishment of a European strong budget, launch of Eurobonds,
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creating a consolidated coordination mechanism of national budgets, achieving of remanent and completely independent national budgets, harmonization of direct taxation and approach of indirect taxation levels.
References Barnier, M., 2012. L’union bancaire sera complète en 2013, Liberation, 4 Août, bruxelles.blogs.liberation.fr/; supervision architecture of financial Dăianu, D., 2013. Content of Regulation and Supervision is the Problem, Colloquy "Towards a new markets in European Union", NBR, 18 July; Elliot, J.D., 2012. Key Issues on European Banking Union, Trade-Offs and Some Recommendations, Global Economy&Development, Working Paper 52, Brookings Institution, November; Georgescu F., 2013. Reform of banking supervision to ensure financial stability and sustainable economic growth, Colloquy "Towards a new supervision architecture of financial markets in European Union", NBR,18 July; Gros, D., 2013. Banking Regulation, Banking Union with a Sovereign Virus, Intereconomics, No. 2-March/Aprilie; Isărescu, M., 2013. Introductive word of NBR governor, Colloquy "Towards a new supervision architecture of financial markets in European Union", NBR,18 July; Schäfer D., 2013.Banking Supervision in the Eurozone, Editorial, Intereconomics, January/February; Speyer B., 2013, EU Banking Union, Right idea, poor execution, EU Monitor, European Integration, September, 4.
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